Understanding company financial statements: EBITDA

When you invest in a company, thorough research forms of vital part of picking the shares you want to invest in.

One thing that you can’t ignore is a company’s financial statements. Companies publish these for the first half of their financial year (interim statements) and for their full financial year (final statements).

A commonly quoted figure from these accounts is EBITDA.

So what is EBITDA? And how can you use it?

Read on to find out…

What is EBITDA?

EBITDA is the abbreviation of earnings before interest, tax, depreciation and amortisation.

It’s basically a company’s earnings before it takes any deductions off.

EBITDA can be a useful way of comparing the performance and valuation of two different companies.

If you compare earnings (or profits) after deductions, figures can appear skewed as they may have different policies on the depreciation of assets, different debt levels and pay different tax rates.

The fact EBITDA ignores deductions is useful, but this is also a downside of using the figure.

The problems with EBITDA

When considering the profits a company makes, as an investor you’re interested in what the company can pay out to investors, not how much money it makes before it has to settle all its dues.

This is where EBITDA isn’t great.

If you want to compare different companies to see how they’re performing, you should take a look at their free cash flow. Free cash flow shows you the money a company is actually making.

For instance, when a company has a lot of free cash flow, it’s more likely to continue paying dividends to its shareholders.

So there you have it. Understanding what EBITDA is from a company’s financial statements.